Definition

The term event-driven strategy refers to an investment approach that attempts to exploit pricing inefficiencies that occur after significant corporate announcements. Event-driven strategies are used by large institutional investors when a company notifies the public of plans that will impact their future earnings potential.

Explanation

Also known as event-driven investing, event-driven strategies are used by large institutional investors, typically hedge funds, to take advantage of certain announcements made by companies. Examples of these events include mergers, acquisitions, divestitures, restructurings, and earnings calls. Following these announcements, the price of a company's common stock will rise or fall, but it will not fully reflect the potential impact of the announcement. This results in a mispricing of the security relative to the event's impact.

For example, a company may announce they are acquiring another business for $35.00 per share, which is a 25% premium over the pre-announcement stock price. In this example, the price of the target company might rise from $28.00 to something like $32.00 per share. It does not rise to $35.00 per share because there is some uncertainty the merger will occur due to factors such as regulatory approvals.

Large institutional investors, such as hedge funds, have the resources to analyze the event and determine with a greater degree of certainty whether or not it will reach its full potential. Based on their internal analyses, they can make a more informed purchase decision and realize greater returns.